What is your ideal target Cap Rate?

Question

Anyone seeing over 8% cap rates out there for multi-plex investing? What is your ideal target cap rate to invest in?

I am in the process of selling some of my SFR and Condo flip / holds that provided a good return on the flip but not the best Cap Rate or Cash on Cash returns so I am in the process of trading up via 1031 exchange to tri-plex / 4-plex / 8 plex etc.

Would love to hear what's happening in different markets out there. I'm seeing approx. 5% cap rate is relatively standard in the Portland, OR area, would love to see 8% or even 10% if possible.

Brian Burke · Answer

The challenge that you are running into is that you are confusing cap rate for a measurement of performance, which it is not. Cap rate is a measurement of market sentiment. People often cross wires when thinking of cap rate so this is a very common mistake.

Rather than buying based on cap rate, you should be buying based on the returns you are seeking, whatever that is. It might be cash-on-cash return, it might be IRR, or maybe equity multiple. Or maybe even on a minimum cash flow per door. Whatever it is, you are seeking to measure performance,  not sentiment.

Cap rate is useful for one thing—estimating the sale price of the property when you forecast your exit—you’ll need that in order to properly calculate IRR or equity multiple.

Taylor L. · Answer

@Brian Burke put it perfectly. Cap rate isn't a measure of how your investment will perform, it's a measure of market sentiment. Well put, sir.

I believe using cap rate as a metric is a recipe for buying dilapidated properties these days. We look at whether we can add value and produce a return that suits our requirement. Cap rate is an input to that, because it impacts how increases in the NOI will be capitalized. But it's just one input into the value add calculation.

Dan Fox · Answer

Thanks everyone for feedback. I appreciate the perspective on cashflow and return being a focus for multi-plex. I realize I like cap rate because it ties the property price and value to income which helps me know I am getting a good value on the property... considering my main focus to date in real estate investing has been buying under valued houses, restoring them back to market condition and profiting on the valuation change it's easy to see why I put so much focus on up front purchase price. I'll try to look through differing lenses as I enter the world of multi's in the coming months/years but I do still love a bargain.

Lien Vuong · Answer

I would op to consider Cash on Cash Return metric rather than Cap Rate. C/C measures how hard your money is working for you.

John Corey · Answer

In most ways, a CAP rate for a house makes no sense. House values are driven by owner occupants. The CAP rate will be of interest to investors yet not a good predictor of the future value for the property. We can use the calculation and it will provide false positives and false negatives.

There are three main ways to value a property.

Comparable method - used with residential when the bulk of the transactions are owner-occupiers purchasing for use and not for income. Residential is 5 units or more so no MFR generally.

Income method  - For commercial property. The structure is nothing more than a container for future cash flow. You are buying the future stream of income. You compare two streams when you compute the NOI and the apply a CAP rate. You pick the best income stream for the money. CAP rates will vary across the different niche asset classes (MFR, trailer parks, strip malls, offices - various classes, industrial, etc). It is uncommon to find owner-occupied corporate properties. Generally a bad use of the corporate's capital to buy rather than lease. They do exist. Just not a great use of capital.Replacement value - Generally only used for insurance purposes. What would it take to replace the property?

Immanuel Sibero · Answer

In that case, I can share what I'm seeing in the market around me and my thought process. A little disclaimer - I'm a relative newbie. I have been watching the SFRs, residential multifamily (2 - 4 plexes), and to a lesser extent , B/C class commercial multifamily (i.e. apartments). Many commercial B/C class multifamily syndicators are delivering "double your money in 5 to 7 years" which roughly translates to 15% IRR. Judging from the level of investors' interest 15% IRR seems to be a good/decent return given the risks associated with this type of investment. So I decided to use it as a benchmark.

For example, I would do an IRR analysis on a potential rental house or 2-4 plexes (using all the necessary assumptions such as holding time and value appreciation, if any, at sale) to make it comparable to a syndication. A syndicated investment is generally less risky, and virtually passive, so I would demand a premium on the return from a rental house to compensate. It doesn't make sense to invest in a rental house that doubles my money in 6 years when I can do the same in a syndication which is less risky and virtually hands-off.

Now, back to cap rate.  Say I find a rental house with 10% CAP in a good area (i.e. not war zone), I still can't tell if I'd be better off just going with a syndication. Is 10%CAP rental house a better return than 15%IRR syndication? Is 15%CAP rental house a better return than 15%IRR syndication? The war zone comment above was a cheap shot... sorry, but I hope I am able to explain in this post why cap rate just does not help me.

Cheers... Immanuel

Jake S. · Answer

@Dan Fox No problem man! I just got the website up finally the other day, it is DEFINITELY a work in progress!!

Dan Fox · Answer

Thanks Jake, appreciate the perspective. Nice job on your website, looks good!

Dan Fox · Answer

Fair enough, I'm not looking to buy in the ghetto for a higher cap rate that's for sure! I am trying to get a feel for what people are seeing as today's good solid investment numbers for their respective markets for multi's.

Immanuel Sibero · Answer

@Dan Fox

I've seen 15% in south Dallas so I went and looked and never went back. It's a war zone, so I decided to quit going by cap rates altogether (not very useful). If Portland has war zones, check them out, there might be "high" cap rates there too.

Cheers...

What is your ideal target Cap Rate?

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